ANALYSIS: Dip in India’s Savings Rate – More of Consumption, Less of Assets

Recent Reserve Bank of India (RBI) data on a sharp fall in savings rate of Indian households during the last financial year has created a lot of controversy.

Critics of the current government alleged that the sharp fall in savings rate to 5.1% of GDP — the lowest in 47 years and considerably lower than 7.2% in FY2022 and 11.5% in FY2021 — was the result of financial stress endured by Indian households. This was countered by government officials, with the interpretation that a dip in financial savings was merely a reflection of the increased tendency of Indian households to save their money in the form of physical assets — such as real estate — instead of financial assets such as bank deposits.

However, a deeper analysis of the related numbers show that the fall in savings rate has little to do with any increased affinity towards physical savings. Instead, it is linked to rising indebtedness of the Indian households. And no, the rising debt is not primarily fueled by the purchase of appreciating assets like real estate, but due to consumption-oriented loans such as for buying cars, meeting medical expenses, education and so on.

This article also compares India’s high levels of household indebtedness to other countries, the high proportion of household income that Indians have to dedicate towards servicing these loans, and the risks that it poses to the country’s economy.

High levels of indebtedness in India

As of the end of FY23, India’s household gross financial savings are at around 11% of GDP. However, liabilities have surged to 5.8% of GDP or Rs 8.2 trillion in FY2023 from around 4.5% in the previous year – marking the second highest level in 50 years. It was higher only in FY07, when it was at 6.7% of GDP.

As a result, household debt now stands at 48.1% of personal disposable income in FY2023, up sharply from 43.3% in FY2020.

Some commentators have attributed the swelling household liabilities to increased investment in real estate by individuals. However, a detailed analysis finds that while housing debt has risen in recent years, non-housing personal loans have grown even faster in the past 18 months. This indicates that general consumption-related borrowing, over and above real estate, has also surged substantially.

Also, an examination of the components of household debt held by scheduled commercial banks, which account for 80% of total household borrowing, confirms this trend. Non-housing personal loans have seen the fastest growth since 2022, followed by housing loans, business loans and agricultural loans.

Several studies have shown that higher leverage inevitably leads to lower savings over time, as a larger portion of income goes towards servicing debt. The rapid growth in non-housing borrowing suggests that general consumption rather than property investment is likely a key factor behind the decline in financial savings.

Credit Deepening or Credit Widening?

One of the obvious question that crops up in one’s mind at this juncture is whether the growth in household debt stems from credit deepening or credit widening trends. Credit deepening refers to an increase in the average number of loans per borrower – implying that existing borrowers are taking on more debt. Credit widening refers to an increase in the overall number of borrowers – indicating wider access to credit rather than individuals becoming more indebted.

Credit widening is viewed as a healthier sign of financial development, while credit deepening can raise risks of over-leverage. An analysis of RBI data over the past decade shows that credit widening has driven the majority (90%) of the increase in household debt. This indicates that leverage has not risen dramatically on a per household basis.

However, the number of loan accounts may not equal unique borrowers, as individuals can borrow from multiple institutions. This makes it difficult to precisely distinguish between widening and deepening trends. More granular data on individual borrowers, rather than loan accounts, would be needed to thoroughly examine this issue.

How Painful: Household Debt Service Ratio

To overcome the limitations of credit widening/deepening analysis and arrive at a more robust estimate of sustainable household leverage, one can look at India’s household debt service ratio. The debt service ratio (DSR) measures the proportion of disposable income that households utilize to service their debt obligations through interest payments and loan amortizations or principal repayments.

A higher DSR indicates households are more burdened by debt servicing costs relative to their earnings. Using RBI and National Housing Bank data, studies estimate India’s household DSR has risen to around 12% in recent years, up from 10% a decade ago. This is much higher than DSRs seen in many advanced economies like the US (7.7%), UK (8.6%) and China (8.5%) despite India’s far lower debt-to-income ratio.

What explains India’s disproportionately high household DSR compared to other nations? Experts have identified two key factors.

The first is the high average interest rates of around 10% that Indians are forced to pay. India has historically had relatively high real interest rates due to structural deficiencies in domestic savings and investments. Rates have fallen from their peaks but remain elevated.

The second is the low loan tenure, averaging around 5.3 years. In comparison, the average debt maturity in advanced economies is around 13 years. Short-term debt means households have to make larger annual interest and principal repayments relative to income.

This combination of high interest costs and limited debt tenures results in substantial yearly debt servicing payments. As a result, even with relatively low debt-to-income ratios, Indian households face higher debt burdens than counterparts in richer nations.

The good news is India’s household debt conditions have improved over the past decade, with steadily falling interest rates and rising maturities. However, the average Indian still faces a much heavier debt repayment burden compared to global standards.

Sustainable Household Debt Thresholds

Very few countries historically have witnessed household debt service ratios exceeding 15% for a prolonged period. Using this as an approximate benchmark, experts can estimate India’s sustainable household debt thresholds.

Assuming no change in average interest rates and maturities, India’s DSR would hit 15% when household debt reaches around 60% of disposable income. This compares to the current ratio of 48.1%. At recent growth rates, India could reach this level in the next 5-7 years.

While household leverage has room to rise further, the pace of increase will likely need to moderate to avoid crossing into risky ‘debt danger zone’ territory. Steps to improve debt affordability by extending tenures and lowering rates can substantially increase the maximum sustainable debt.

Risks of High Household Leverage

Studies show excessive household debt weakens balance sheets and impacts growth. Heavily indebted households allocate more income to repayment, reducing discretionary purchases. This was seen in the United States before 2008 as debt costs crowded out consumer spending.

High household leverage also increases financial instability risks, often preceding full-blown banking crises as in Denmark, Iceland and elsewhere. Beyond financial risks, high borrowing dampens consumption and output. Economies with sharp leverage growth like South Korea subsequently suffered weaker consumer demand despite rising incomes.

Excessive household debt lowers long-run GDP growth rates as well, with countries that saw larger run-ups in borrowing experiencing greater slowdowns. High leverage also exacerbates recessions through procyclical effects – indebted households are forced to cut spending further during downturns.

Borrowing excesses also worsen inequality, as poorer households rarely over-leverage while the affluent borrow heavily. These imbalances distort asset allocation and widen income gaps evident in the United States. Finally, lack of oversight enables predatory lending practices that heighten financial instability risks seen in the US subprime mortgage debacle.

In summary, while some increase in household credit to support growth is beneficial, excessive leverage carries economic and social costs. India must expand access prudently while instituting safeguards to prevent over-indebtedness through measured policy steps.

Another factor to be taken into consideration here is that only around one-quarter of Indian adults have formal credit access, far below penetration in advanced economies, signaling significant room for expansion. India’s mortgage-to-GDP ratio is also just 10% versus over 50% in developed countries, indicating enormous potential for further growth. Rising working-age population incomes will spur borrowing demand.

Similarly, there is disparity between the urban-rural populations as well. Urban areas have seen faster credit growth but rural income volatility raises debt distress risks. Salaried groups are taking on more debt but have income stability to service it better. Poorer households have inadequate finance access still while the affluent leverage excessively, worsening inequality. Older households more dependent on savings face larger repayment burdens.

Targeted policy interventions are essential to address these varied dynamics across income levels, geographies, employments and age groups. Broad-based tightening could hurt poorer households and small entrepreneurs disproportionately.

In rural areas, the situation is somewhat different. Formal credit reaches less than one-fifth of rural households versus over 60% of urban households. Volatile farm and non-farm incomes increase repayment risks. Healthcare emergencies are a key borrowing reason, indicating need for greater public health infrastructure and insurance. Lower formal credit access makes rural households prey to illegal moneylenders with exorbitant interest rates. Expanding agricultural credit facilities is also a priority.

Focused efforts on financial inclusion, strengthening social security, preventing predatory lending and channeling credit into productive uses are required to expand rural access while minimizing over-indebtedness risks.

In short, while Indian household debt remains moderate in aggregate relative to incomes and GDP, the rapid pace of recent leverage growth is a concern. Debt servicing burdens are already unusually high compared to global norms even at current debt levels. The growth has been consumption-driven rather than just reflecting producer investments in housing.

Policymakers need to pursue a calibrated approach – facilitating wider access to credit to support growth while strengthening oversight to prevent excess. Improving household savings rates is also imperative to reduce leverage